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Money talks

Monday 15th August 2016

On 4 August the Bank of England (BoE) cut the Bank Rate to 0.25% and has introduced a package of measures designed to provide additional stimulus. The monetary stimulus, otherwise known as quantitative easing (QE), is basically the BoE pumping money into the system by creating it electronically. It uses this money to buy UK Government Bonds and Corporate Bonds from financial institutions, such as banks and pension funds, which means the yields on these asset classes become lower, which reduces the cost of borrowing.

The idea of increasing the money supply in the system is to encourage financial institutions to lend more, thereby stimulating the economy: the so-called ‘trickle down’ effect. Whether this happens to the full extent is a moot point as banks could simply hoard the money.

And this is where it could get very difficult for banks. Lending banks have bank accounts with a central bank – in the UK that’s the BoE. Cutting the interest rate – which is central bank sign language to financial institutions for ‘lend more’ – means high street banks get squeezed from both ends. They get lower returns on their lending and they’re not earning much from any deposits. To mitigate this, the BoE have launched a Term Funding Scheme (TFS) that will provide funding for banks at interest rates close to the Bank Rate. Let’s hope this works. If the high street banks are already feeling the pinch then they could pass the cost on to their customers – hence recent announcements in the press that some banks could consider imposing ‘negative interest’ rates on their business customers.

The markets currently don’t appear too worried, in fact the UK stock market has gone up with prospect of more money going into shares, but these are troubled economic times that require careful policymaking – with no ‘silver bullet’ to fix those woes.

A version of this article orginally appeared in the Isle of Wight County Press, Friday 12th July 2016